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Planning Retirement Online

 

Retirement Income

 

Sources of Retirement Income

To make any decisions, you need to understand the pensions system because it will normally be your pension provision that funds your retirement. You may choose to make other investments during your working life into things such as Bonds, ISAs, Property and so on. You may even invest in Fine Wines, Antiques and other areas in which you are interested but, for most people, it will be pensions that will fund our retirement.

Pension PlanPensions

The UK currently operates a three tier Pension system which comprises the Basic State Pension, a State Second Pension and finally personal provision provided through either an Employer Sponsored Scheme, or Private Pensions.

The objective of this three tier approach is to provide pensioners with a minimum flat rate state-provided pension, sufficient merely to prevent poverty, supplemented by an earnings related ‘top up’ pension (state second pension), and finally an occupational or private pension. This third tier has historically been the most important element of provision, having often been a Defined Benefit Scheme offered by an employer but more typically these days a Defined Contribution Scheme offered by an employer in which the contributions we (and our employer) make are invested in the stock market.

There are a lot of different types of pension, but they can be put under the three broad categories: state, workplace, and personal, described below. State pensions are provided by the government, workplace pensions are available through your employer, and personal pensions are set up by individuals.

State pensions

The state pension forms the backbone of many people's retirement income. At retirement it provides you with a regular income for the rest of your life from a reliable source. However, for the majority of people, it will never be enough to live on comfortably, so it's a good idea to build a pension elsewhere.

The state pension has also been through many reforms, making it very complex.   Fortunately, the gov.uk website has a state pension forecaster and a state retirement age planner. Based on today’s rates the basic state pension is £107.45 per week.

If you are well into your career it’s a very good idea to get a state pension forecast so that you know how much you will receive when the time comes and you reach state pension age.

It will have two elements to it: the basic state pension which we receive if we have paid National Insurance contributions and a second element, the State Second Pension, which we get for every year that we have been contracted into it. Some company pension schemes are contracted out, which is why you may have periods of working life for which you will not build up any State Second Pension.

However from 6th April 2012 the only people contracted out and not building up a State Second Pension are people with final salary schemes where the scheme has chosen to contract out, although this may also change in the future. The calculation of the State Second Pension is extremely complex and for most people the only current way of understanding what it might provide is to get a pension forecast as described above.

Also please note a new State Pension system comes into effect from 6 April 2016. The Pension Advisory Service web site  provides you with information on how those reaching State Pension age (SPA) before 6 April 2016 and those reaching SPA on or after 6 April 2016 are affected.

Once you know how much you will receive, you might then start to think about whether you want to take it at the earliest possible opportunity or whether you want to defer it and get an increase in your pension when you do claim it. Go to https://www.gov.uk/deferring-state-pension/what-you-may-get  to see what the implications are.

The State Pension is an important element of retirement, so make sure that you are fully conversant with how it works, how much you will receive and when you want to take it.

Workplace pensions

Workplace pensions vary from company to company but the key benefit – the employer's contribution – is effectively free money towards your retirement so it's worth taking a look at what your employer offers.

Some workplace pensions offer a facility called salary sacrifice or salary exchange. While the name may be off-putting, this is essentially a way of paying less tax and national insurance and getting some or all of that saving paid into your pension. So if your employer offers this, it is well worth asking them for more information.

Auto-enrolment

Auto-enrolment is a new law that requires employers to automatically put their eligible workers into a workplace pension scheme, without the employee having to request it. October 2012 saw the start of the auto-enrolment system, which is expected to take six years to be fully rolled out. Under the new system, initially any workers over 22 years old and under the state pension age, not already in a scheme and who earn more than £5824, will automatically be enrolled.

Workers employed by the UK's largest firms (those employing more than 120,000 people) from 1 October 2012 have started to be automatically enrolled into company pension schemes. Between now and 2018 all other employers will have to ensure that UK-based workers aged over 22 years who are in the qualifying earnings band £5824-£42,385  (for the 2015/16 tax year) are also enrolled into a pension.

Employees will initially see a minimum of 0.8 per cent of their net earnings allocated to their workplace pension. Their employer will contribute 1 per cent of their earnings and tax relief adds a further 0.2 per cent. From October 2018, these amounts will increase to a minimum of a 4 per cent contribution from the employee, 3 per cent from the employer and 1 per cent in tax relief.

Personal pensions

Personal pensions allow investment into the pension provider's own in-house funds, or a range of external funds. Typically, there is a choice of around two hundred funds, although the choice varies from lows of around a dozen to highs in excess of 1,000, depending upon the provider. The funds available will typically cover different industries, geographic regions and investment objectives.

SIPPs – self invested personal pensions – are a type of personal pension that allow an open choice of fund managers and other investments such as direct investment in equities. They may also allow you to appoint an expert investment manager or to invest in more exotic investments such as direct investment in commercial property.

Stakeholder pensions

Stakeholder pensions meet particular minimum standards on charges and contributions. They may be particularly suitable for those making lower contributions.

Multiple pension pots

It may be that through moving organisations and other changes in our working lives we accumulate a number of pension pots. This may lead to lack of a consistent investment strategy across all of them and possibly duplicating some charges. Although there is some potential diversification benefit should one provider have problems (such as the well publicised Equitable Life problems in the 90s) it is worth considering consolidating pensions with the help of a Financial Advisor.  

Other retirement income

For most people pensions are the primary sources of providing an income in retirement, so saving enough to ensure that you will be comfortable for the period of your retirement is extremely important.

However some people do also rely on other sources such as property investments, ISA investments, sale of a business, equity release etc. However as a rule of thumb the special tax treatment of pensions usually makes them much more effective in building up funds.

To get an idea of the degree to which they are more effective you can take a look at our page on ISAs v Pension schemes

CONTINUE TO: Should I get a pension?

NEXT STEPS

The rest of the Guide covers the other aspects of planning your retirement finances. We suggest you read through the whole guide to gain a general understanding and then work through the appropriate sections to develop your personal ideas.

If you've done your initial retirement planning then use our checklist: on a regular basis:
Reviewing Projected Retirement income - Checklist

However if you feel that you need some help from a financial advisor, then visit our section on obtaining financial advice, or our page on Laterlife selected services and associated advice.

 

 
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